Twitter's Potential for Profit

One of the leading topics these days, especially among investors, is Twitter and its impending IPO.

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Earlier this month, the microblogging giant, Twitter Inc., filed its prospectus for an initial public offering. I've always said I would be interested in taking a very close look at Twitter if it went public.

Unfortunately for me, Twitter is taking advantage of a new rule that allows US companies with less than one billion dollars in revenue to file for their IPO confidentially. This hinders analysts, everyday investors, and the press from digging into Twitter's financials or business strategy until shortly before the company's stock market debut. Until I can see real numbers, I'll have to be satisfied reading the industry scuttlebutt and thinking about where Twitter's business may go in the coming years. Henry Blodget from BusinessInsider.com wrote just such a piece, referencing research from Wall Street analyst Robert Peck. It seems Twitter is expected to go public with a market capitalization of about $20 billion, which would represent 17 times next year's revenue estimate. This means, analysts think, admittedly based on very limited information, that Twitter will do about $1.2 billion in revenue in 2014. This seems like a crazy high multiple, until you realize that both Facebook (NASDAQ:FB) and LinkedIn (NYSE:LNKD) have gone public with similar forward revenue multiples, and both are posting excellent annual growth, which could justify their valuations.

I see tremendous potential for Twitter in the coming five to ten years. Out of nowhere, they've become the go-to place for any kind of headline, from technology, to finance, to Hollywood entertainment and gossip, to politics. Before Twitter, I found most of my industry-specific headlines from websites such as Yahoo Finance or by subscribing to the RSS feeds of websites that I liked reading. Twitter is superior, in my opinion, because it allows me to follow all the websites I love, but also lets me follow specific people, who will share interesting news that I'd have missed otherwise. Twitter also represents a well-organized, constantly updated flow of what's going on right now.

People care deeply about news and information in their areas of interest. I think this has more value than the kind of personal updates most people post on Facebook. It keeps people coming back.

I think Twitter should have excellent monetization opportunities. Need to hire for a specific role? Promote a tweet to people who follow Twitter accounts related to the topic in question. Want to tell the world about a new product? Whether it be recruiting, product advertising, or brand awareness, Twitter is built around users who follow other users, and that information reveals a lot about a person's likes and interests. I think this should drive incredible growth in advertising. It might also drive subscription-based revenue for firms who need to use Twitter's data to analyze trends or generate other useful analysis. The team of people who run the company on a full-time basis can surely come up with better monetization strategies than I can.

Consider that Twitter has only 200 million active users, as of February, and is expected to post revenue of $1.2 billion next year. I have to wonder whether we could see ten times that level of revenue inside of ten years. If so, I think it means there is powerful upside potential in the stock.

As a long-term investor, I'm very interested in seeing if Twitter can go from dominant in the headlines to dominant in making money from the headlines. Right now, it is the clear leader. With good execution, I suspect the company could make more money than LinkedIn ($27 billion market capitalization) and perhaps as much as Facebook ($115 million market capitalization).

Once I see the financials, I'll have a better idea of whether or not I want to pull the trigger on a Twitter share purchase. If I do, my intention would be to hold for a decade or longer. As with anything quite new, things can change. Twitter could lose out to a newer, better way of getting quasi real-time information on what matters to people. Or it could be outgunned by a company like Google (NASDAQ:GOOG) via its social network, Google Plus. I'd have to keep a close eye on whether the opportunities I've described here are indeed materializing. I'd look to sell only when the reasons I bought were no longer valid.

I'd also have to accept, as always, that a stock like Twitter is bound to be hugely volatile. I might invest at one price and see the stock plummet 50% at some point. If you can't stomach something like that, please don't invest. But to me, I'm very interested in taking the risk on short-term volatility when I think there is an opportunity for a multibagger over the next decade.

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